Thank you for standing by. This is the conference operator. Welcome to the Westport Fuel Systems Third Quarter 2019 Financial Results Conference Call. As a reminder, all participants are in a listen only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions.
I will now turn the conference over to Sean Severson at Alpha Direct Advisors, Westport's Investor Relations representative. Please go ahead, Mr. Severson.
Thank you, and good afternoon, everyone. Welcome to Westport Fuel Systems' 3rd quarter conference call, On today's call, speaking on behalf of Westport Fuel Systems is Chief Executive Officer, David Johnson and Chief Financial Officer, Richard Orszetti. Attendance at this call is open to the public and to media, but questions will be restricted to the investment community. You are reminded that
Before I discuss our business, let me take a moment to introduce and welcome Westport Fuel Systems' CFO, Richard Ortezetti. Richard joined our team Richard joins us at a pivotal time, pivotal for the company, pivotal for the industry and now also pivotal for Richard. He's had a distinguished career with extensive experience in corporate finance, risk management, operational management and strategic planning, to name just a few. I know you all joined me in welcoming Richard to Westport Fuel Systems. First, the headline financial results.
I'm pleased and proud of what we achieved in Q3. The continued growth of HPDI sales combined with our strength in independent aftermarket and light duty OEM businesses resulted in transportation revenue of $75,400,000 up 15% from a year ago. Q3 net income from continuing operations improved by $17,000,000 to a gain of $4,900,000 compared to a loss of $12,100,000 from the same quarter last year. We recorded our 3rd consecutive quarter of positive EBITDA and our 6th consecutive quarter of positive adjusted EBITDA. We created $3,500,000 of positive cash flow from operations before changes in working capital compared with the use of cash for 11,600,000 in Q3 2018.
These results are evidence of growing global demand for our clean transportation systems. Our customers are deploying our products and technologies to deliver clean, cost effective transportation in markets around the world. Today, there are roughly 1,300,000,000 cars and trucks on our road today. Each year, our industry produces and sells Nearly 100,000,000 new cars and trucks and a new car truck built today is likely to be used for the next 20 years. Commercial trucks power our economies and passenger vehicles enrich our lives.
But in total, they consume a massive amount of energy, 120 Quads, that's 120 Quadrillion BTUs annually according to the EIA. Most of that is in the form of gasoline or diesel. Transportation is the 2nd largest producer of CO2. Demand for transportation will continue to grow and the clock is ticking with respect to our well understood challenge of climate change. We need to take action without delay to reduce the carbon intensity of transportation.
We need solutions now that move the needle. To move that needle, we must produce and sell a lot of vehicles that are better for the environment. We need affordable clean transportation urgently. Westport Fuel Systems products meet this challenge. Our products fueled by natural gas reduce CO2 emissions by 20% versus liquid hydrocarbons.
That's gasoline and diesel. And they do so today and every day. Moreover, we're seeing a rapid and increased use of renewable natural gas where our products are offered. For example, about 70% of all the gaseous fuel burned in commercial vehicles in California is renewable gas and more than 90% of all gaseous Fuel used in vehicles in Sweden is renewable. Our products are developed.
They're validated. They're in production and for sale and in use There's no waiting required. Ours are products, not prototypes. There's no need to wonder how far does it go? Can it meet my needs?
When can I drive 1? When can I buy 1? How much will it cost? We know these answers for Westport Fuel Systems products. And Westport Fuel Systems products are affordable.
The payback on the incremental cost is less than a year in most passenger vehicle applications and 2 to 3 years in most commercial vehicle applications in many markets around the world. And applying our products to existing vehicles and to new engines and new vehicle production is easy and also affordable to achieve. No new manufacturing technology or plant is required. Existing vehicle and engine manufacturing can be preserved No massive capital outlays required to build new plants, giga or otherwise. And our products meet the most stringent emission standards, including those in Europe, China, India, North America.
And we know this because we are delivering our products to our customers every day in markets around the world. You can see them on the roads next to you. Let me now turn to the important regulatory drivers of our business. More and increasingly stringent regulations in China, India and Europe are driving the marketplace and are driving our business to increased scale. On prior calls, I've spoken to Europe's heavy duty CO2 regulations and India's decision to move directly to Bharat Standard 6 emissions, which are roughly equivalent to Europe's Euro 6 standard.
While the market LNG fueled long haul trucks is growing today in Europe, the Chinese LNG truck market is already the largest in the world. The new China 6 emissions regulations, which align with Europe and North American standards, take effect in July 2020. Sales of LNG fueled heavy duty trucks in China for the first half of twenty nineteen were 85,000 units, up more than fourfold compared to the first half of twenty eighteen. China is a critical market for us. We've been working together with Weichai in this important market.
We're excited about the progress being made and the future of HPDI in China. Let me offer a few examples about what scale looks like. UPS recently announced that they will spend $450,000,000 to add 6,000 vehicles powered by natural gas along with the supporting fuel stations beginning in 2020. It was the largest Multiyear Commitment UPS has made for alternative fuel vehicles and include heavy duty trucks, medium duty package vans and terminal tractors. Natural gas is not a test or an experimental phase at UPS, but rather is mainstream in their fleet.
The low total cost of ownership of natural gas vehicles enables scale. The build out of refueling infrastructure is another indicator of scale. In order to meet CO2 emissions reduction targets, sales of cleaner, more efficient vehicles must ramp up dramatically as must refueling infrastructure. In the case of natural gas, this is well underway in markets around the world. For example, at the start of 2019, there were 170 LNG stations in Europe.
Now there are 231 stations, including the first LNG station in Belgium. That's a 35% increase just this year. There are now LNG stations in 18 countries across Europe. New stations are coming online quickly 500 LNG stations projected by 2022, 2000 stations by 2,030. Let's contrast that growth with the reality that there's not yet one single public electrical charging point or public hydrogen filling station in Europe for long haul trucks.
This scaling of infrastructure is not limited to Europe. There are currently about 6,500 LNG stations in China and their stated goals to increase that number to more than 10,000 within next year. In India, Total and Adani Gas recently announced their plan to build 1500 LNG stations over the next 10 years. Increasing product choice for individual consumers and fleets in all geographic markets is another driver of scale. Just a few examples to illustrate this.
The global market for LPG and CNG conversion kits is approximately 1,000,000 kits per year and our independent aftermarket business has a 30% share of that market. Argentina, Italy, Poland, Russia and Turkey are well established and critical markets for our business. The global market for delayed OEM installations is about 35,000 units per year, and Westport Fuel systems has more than 90% share of that market. Our PRINS division has expanded its LPG and CNG delivery program to more than 100 new models for the latest direct injection engines. Kia recently announced the availability of their LPG fueled Sportage for the Italian market.
The global market for OEM production LPG CNG fueled light duty vehicles is approximately 500,000 units per year and again Westport Fuel Systems has about a 30% share. Leading manufacturers in India have publicly stated they expect a sales mix of natural gas potentially greater than 30% in the very near future. Before I hand over to Richard, let me make one more point. And to do so, I'll draw on the analysis that our own Mark Dunn presented last week in Michigan at the Innovations and Mobility Conference of SAE International. The path to sustainable transportation must be led by cost competitive, Market Ready Technologies that move the needle in both performance and scale.
Westport Fuel Systems HPDI, for example, enables a 20% reduction of CO2 versus diesel engines at a low total cost of ownership and will help OEMs respond to increasingly demanding regulations. But this is just the starting place as HPDI, like many of our product offerings, enables further greenhouse gas reductions when renewable natural gas is blended with or replaces fossil nitri gas. This means that Westport Fuel Systems products allow OEMs to respond to the current and future regulations and market needs, while preserving their considerable capital investments in the engines and trucks they make and sell today, all while delivering fully capable vehicles to their customers. Westport Fuel Systems products in combination with renewable natural gas are a real path to deep Decarbonization of Transportation. The potential to get to net zero carbon for trucking in Europe and globally using HPDI is available to us now and this can be done with a competitive total cost of ownership as compared to diesel with no sacrifice in performance, Reliability or Durability.
This market data validates what we hear from our customers around the world. Trends that we also see in our financial results, our order book and our development activities for our customers. The strength of our OEM and aftermarket business in key markets and the growth of HPDI in Europe and upcoming launch of HPDI in China ensure that we are well positioned to capitalize on the opportunities. Finally, let me remind you of our 2019 strategic priorities: deliver sustained growth accelerate our HPDI commercialization and align our cost structure with our revenues to improve cash flow and operating results. We're pleased with how the 1st 3 quarters of 2019 have delivered on this promise, and we're looking forward to the rest of the year and beyond.
With that said, I'll turn it over to Richard to review Q3 2019 financials.
Thank you, David. This is my first quarterly financial results call since starting with Westport Fuel Systems in early September. I'm excited to be joining Westport Fuel Systems at this point in time in the alternative fuels industry and also having Fuel Systems and the embodiment of the vision, creating a better world through innovative energy solutions. I've also had the chance to speak with many of our shareholders and analysts that cover the company, and I look forward to meeting with more of you in the near future. Turning to the financials, we had a strong third quarter on many fronts from the continued strengthening of our operating performance our 3rd consecutive quarter of positive EBITDA of $11,700,000 6 quarters of positive adjusted EBITDA.
To review our Q3 results in more detail, I'll begin on Slide 2. We closed the quarter with sales of 75 $4,000,000 net income from continuing operations of $4,900,000 and positive adjusted EBITDA of 9,400,000 Our Q3 adjusted EBITDA was an improvement over our Q2 2019 and our Q3 2018. The improvement over the prior periods is a result of strong sales during the quarter and reduced operating costs. Turning to Slide 3, we look at our transportation business segment. Transportation revenue was up 15% compared to the same quarter in 2018, primarily due to the strength in our HPDI and delayed OEM sales.
The aftermarket business revenues were consistent with the prior year quarter in euro terms, but declined 4% in U. S. Dollar terms. 3rd quarter 2019 OEM revenues increased by $11,800,000 or 64 percent over the prior year quarter. HPDI product sales and development revenues were the primary driver for this increase.
Gross margins were in line with expectations with prior quarters. We do expect lower margins in Q4 2020 due to launch costs and volume related price discounts that are partially offset by material cost reductions. As a result of the increased sales and reduced R and D spend, adjusted EBITDA in our transportation segment improved significantly over both last quarter and versus Q3 2018. Turning to Slide 4, we'll review the results of our CWI joint venture. CWI recorded revenue of $83,000,000 in the Q3 2019, a 1% decrease over the Q2 of 2019 and a 4% decrease over Q3 2018.
The current quarter was impacted by a $3,800,000 negative warranty adjustment as compared to a $600,000 positive warranty adjustment in the prior year quarter. Lower sales in the negative warranty adjustment led Turning to our sales and general and administrative costs. SG and A costs decreased over the prior year, mainly due to the completion of the SEC investigation, which impacted our Q3 2018 results by $3,500,000 of legal fees and advisory compared to nil in the current quarter. Lower stock based compensation expense, lower salary expense and lower discretionary costs also resulted in lower SG and A for the quarter. The management team has worked hard to reduce costs at the corporate center Strategic Direction of the Company.
During the quarter, we also negotiated a settlement of a payable to a government related technology funding agency $4,600,000 which resulted in a $3,300,000 gain during the quarter. The gain on settlement was recorded in interest There was positive cash flow before working capital changes of $3,500,000 offset by cash used in working capital of 6.7 We paid principal and interest payments for debt and royalties of $6,600,000 We had capital expenditures of 1,800,000 and we had a $1,000,000 impact of the lower euro. We continue to service and pay down our debts on schedule, Which we will continue to do from our operating cash flows and financing facilities to optimize our borrowing costs. While we do not have any specific plans to raise capital at the moment, we will continue to evaluate our liquidity and financing needs to support the growth of the Company and strengthen its financial position. As I reflect on Westport's progress in creating a growing and sustainable company, I am impressed with the improvement in operations across our lines of business since the merger with Fuel Systems Solutions.
As you can see on Slide 6, we went from a negative $46,000,000 in adjusted EBITDA in 2016, working towards positive $25,000,000 through the 1st 9 months of 2019. This is a remarkable turnaround and a recognition of the tough decisions made by the Board and management and hard work of Westport employees over this period. Now turning to guidance. Based on our strong year to date results, we are revising our annual revenue guidance to $295,000,000 to $305,000,000 for 2019, up from $285,000,000 to $305,000,000 We look forward to ending the Craig Hallum Investor Conference in New York City next week. With that, I'd like to turn it back to the operator for your questions.
Thank you. We'll now begin the question and answer session. Is from Colin Rusch with Oppenheimer. Please go ahead.
Good afternoon, everyone. This is Kristen on for Colin. I was just wondering if we could start with the OEM and the DOEM business. And can you provide some additional color on the strength that you mentioned in those businesses and maybe break out the 2, and where you're seeing that Sequential Growth in that light duty business.
Yes, nice to hear your voice, Kristen. Glad to come back on the discussion of OEM and DOEM. We don't have a specific breakout for But I can give you a little color. Basically, our DOEM business, I would say, is the stronger growth story within that. And really that reflects the flexibility that we have with respect to the OEM.
We can take a product from a manufacturer and create a DOEM kit and get the DOEM business started very, very quickly, so in a matter of 6 to 9 months, if you will. And so on that basis, we can be very responsive to what's happening in the marketplace. And so that's really driving our business. I did mention, you might recall from the last quarterly call, how we had a real strong showing with respect to tank valve production and deliveries in Q2 and that I indicated that was a very good sign for what was coming with vehicles in the market in the future. And I noted that just today there More than half of their golf models were sold with natural gas fuel systems, including our components.
And so that gives you an idea of the strength and the potential of not only the DOEM, but the OEM market, when the products are available and in markets where the fuel is available. And so we really see tremendous growth potential on a go forward basis for those products.
That's great. Thank you. And then next question I wanted to ask is just on the R and D side, are you seeing any particular areas of investment where you feel like you need to be making that commitment right now?
As a general principle, we're very happy that we have a complete set of products in the marketplace that respond to the demands for Clean transportation products meeting emissions requirements, meeting customer demands and so forth. Nonetheless, the market doesn't stand still and we continue to invest in developing next generation products. We feel that pull from our customers, both on the light duty side and the heavy duty side, and we're responding to it. But I would tell you as a general principle, we don't see the need for massive investments to hit some new standard or something like that. And so it's more a keeping our products competitive in the marketplace and being ready for that next round of emission standards and things.
And if I can sneak in just one more, can you provide an update on the discussions with CWI and the sunset of that JV for the end of next year?
Yes, I'd love to do that and I look forward to doing so. At this juncture, I don't have any news or update to share with you. Our situation is as it was in Q2 in terms of We have a contract. We're proceeding to do business and we're having discussions around what comes next in the phase. But at this juncture, unfortunately, I have nothing I can share.
Great. I appreciate the questions. We'll take the rest, and get back in the queue.
The next question is from Eric Stein with Craig Hallum. Please go ahead.
Hi, David. Hi, Richard.
Hey, Eric. How are you?
Great. You?
Good. So on the OEM, appreciate the detail there, the nearly $12,000,000 increase year over year. I'm just wondering your commentary about HPDI being the primary driver. I mean, any way to dial that in a little further? Are you saying that it was Greater than 50% or maybe some type of percentage would be great.
And then also, I'm just curious, obviously, you're seeing good traction, steady traction there with Volvo. Is that something that where you saw sequential improvement in volumes?
Yes. Thanks for the question. And let me just Provide what I can in that regard. And basically, as you know, our business is with our European lead customer and we I had a small start with our Chinese customer. And so the vast majority of our revenues in the HPDI business today are still driven by the one customer.
And so We're not breaking it out. I apologize for that. But yes, in terms of sequential growth, we continue to see that. So we continue to work with our customer and we Plans for product enhancements and all sorts of good things in the future, but it's driven by the demand in the marketplace and we do see those volumes continue to move forward.
Okay. It was worth a try.
Yes,
absolutely. Maybe just turning to the pipeline, I know and I can appreciate you can't necessarily talk about specifics, specific OEMs and programs. But know in the last quarter you did add a development agreement to that pipeline. And so with that in mind, I mean, as the CO2 standards come on, as we go through this year where they're setting the baseline, I mean, how do you anticipate that pipeline, the speed in that pipeline, how fast those programs move forward or decisions are made whether to move forward or not.
Yes. A couple of comments on that. It's our normal business development programs with OEMs around the world for both light duty and heavy duty product. And what I can tell you about that is The decisions aren't so predictable and the programs are very lumpy. And so what I mean by that is, one day we're not working with a given OEM and the next day we are and then It's a fair bit of work.
So it's a challenge for us to manage. And in this timeframe, right, as we look out into the beginning of the 2020 to 2,030 timeframe and the regulations that are coming on both in light duty and medium duty and the need to reduce CO2 and then the affordability and availability of our products, My expectation is that those development revenues will grow and will be more interesting in the future than they are today. And I look forward to making announcements about such things, but Yes.
Got it. Maybe last one for me, just turning to aftermarket. It looks like that was down a little bit versus the prior year. Just curious, I know a lot of moving parts You're in, what, 90 different countries, but just maybe some of the main markets and the puts and takes to that.
Yes, we saw really good. So as you mentioned, we have a number of key markets where we're very strong. It's important part of our business. We mentioned some of those earlier in the call. Italy, for example, is a really important market for us and hence we have our operations there and a long presence there.
And the growth Good. The pull on the product is strong there. Meanwhile, in places like Poland, we also see growth in Russia too. So Those markets are really important to us and even in Argentina despite all the turmoil there we see good results. So I know there's a desire for Further breakout of results from country to country, but we have that in our future perhaps and we look forward to doing that.
Okay. Thanks a lot.
Our pleasure.
The next question is from Rob Brown with Lake Street Capital Markets. Please go ahead.
Earlier this year, how have you seen the truck makers responding, I guess the ones that aren't your direct partners, but are they in the How would you characterize where they're at? Are they in a decision making stage yet or are they really in the evaluation stage and maybe just some color on how the market's been changing over this year?
Sure. In general, what we see is our lead customers, I would say, in a very strong position and they know they are with respect to leading the And having our HPDI system available for their customers today. And the other OEMs in the marketplace that we work with all the time, I can't be specific, of course, but they're all weighing their options and considering what their portfolio will consider in the future and making their decisions. And so Our work with each one of them, unfortunately, for the most part, it's going to remain a supplier secret until such time as our customers decide they're going to make an We won't be making those announcements. But I do see as a general premise that right now because of that regulation and increasingly as the clock ticks away, The intensity of the discussions and the work we're doing is growing and so that's exciting for us.
Okay, good. Thank you. And then on the Weichai program, did you say that it was entering final kind of testing and just wanted to clarify what you said about the timeline there. Do you have a sense on when that happens and how that might affect launch time.
Yes, glad to talk about Weichai. Our work with Weichai continues very strongly and Where we are in that project is basically in the final stage to get certification completed and certified, if you will, by the agency in China, the Chinese DPA. And I expect that soon, but frankly, it's not a timing we control and that's our challenge as a team. All the work we do and we have to overcome all our challenges and deliver the product and we've done that. Now it's the certification step, which unfortunately isn't so controllable.
And so we do see some risk that we won't achieve exactly the curve and the time that we were hoping for and planning on, but it's not out of our grasp yet. So we're still working on
Okay. Thank you. I'll turn it over.
Thanks, Rob.
The next question is from Chris Souther with Cowen and Company. Please go ahead.
Hey, thanks for taking my question. For Weichai, you discussed the certification process I just wanted to see, is there anything that is in your hands at this point with that launch or anything that's left for you guys to do specifically?
Yes, that's a great question. I would say basically, other than continuing to support our customer and work with them as they face any challenges, there's no So in our business, we take our components, design them and validate them and then PPAP them and deliver them to customer. And we're in that condition where all our
Session. Got it. And then, a few people have other kind of tried to touch on this, but Total Launch Partner. Can you talk about any regional commentary? In the past, you've kind of mentioned specific markets where there were kind of initial launches.
Anything you can kind of give to that factor? If not, you discussed Yes, the kind of the ramp up in stations, is it fairly similar kind of markets we should be looking at to kind of follow where you might be seeing strength there?
Yes. The infrastructure build out, I would tell you, is probably one of the most important indicators of where you'll see truck sales growth next. And there's really good data on the web about where they are today and where they're going to be in the future. So I think that is more than anything else kind of the key ingredient on where the regional growth is and where the trucks are going to have the greater market share sooner. It's really hard to summarize in a call and go through all that data, so I won't even try.
But as a general principle, I also struggle with They're not our sales of vehicles and so we don't have the detailed data ourselves. So what we're going off of as we see it is announcements of infrastructure and announcements of fleets that say look at we're proud we bought these trucks and they're working great for us.
Excellent. And then, just my last one. Is that $3,200,000 service revenue that you called out from development work with an OEM. Is that related to HPDI and go through the OEM kind of segment that you discussed or is that something different?
Yes, that's one of our heavy duty programs and yes, so that should yes.
Okay. So that's included in When you say the majority of that OEM increase is related to HPDI, it's in there, I guess, right?
Exactly.
Perfect. I'll hop in the queue. Thanks guys.
Thank you.
This concludes the time allocated for questions. I'll now turn the conference back over to Sean Severson for closing remarks.
Great. Thank you everyone for joining us today and thanks again for your interest in Westport Fuel Systems.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating and have a pleasant day.